In re Westby, 11–40986.

• Decision Date: 04 April 2012
• Docket Number: No. 11–40986.,11–40986.
• Citation: 109 A.F.T.R.2d 2012,473 B.R. 392
• Parties: In re Dustin Jay WESTBY, Brandi Michelle Westby, Debtors.
• Court: U.S. Bankruptcy Court — District of Kansas

473 B.R. 392

109 A.F.T.R.2d 2012-1768

In re Dustin Jay WESTBY, Brandi Michelle Westby, Debtors.

No. 11–40986.

United States Bankruptcy Court,

D. Kansas.

April 4, 2012.

Bruce C. Barry, Manhattan, KS, Jill A. Michaux, Neis & Michaux PA, Topeka, KS, for Debtors.

Memorandum Opinion and Order Overruling the Trustee's Objection to Exemption

JANICE MILLER KARLIN, Bankruptcy Judge.

Under new legislation effective April 14, 2011, a Kansas debtor in bankruptcy is entitled to exempt from the bankruptcy estate the right to receive the federal and state earned income tax credit (“EIC”).¹ A general debtor in Kansas not proceeding under bankruptcy, however, is not entitled to this protection. The Trustee has objected to the Debtors' use of the exemption based on the Uniformity and Supremacy Clauses of the United States Constitution, as well as the textual application of the statute.

Because the Kansas exemption statute is a state, rather than a federal enactment on the subject of bankruptcy, this Court finds no Uniformity Clause violation. In addition, because of the concurrent nature of state/federal authority in bankruptcy, and because the Trustee has shown no express conflict between the exemption statute and the Bankruptcy Code, nor an implied conflict between the given exemption and the language and goals of the Bankruptcy Code, the Court finds no Supremacy Clause violation. The Court also rejects the Trustee's additional challenges based on the reference within the exemption to “the federal bankruptcy reform act of 1978 (11 U.S.C. § 101 et seq.),” reprioritization of the payment of claims, unauthorized transfer, conflict with portions of the Internal Revenue Code, and the application of the “right to receive tax credits” language from the exemption. The Trustee's objection to the exemption ² is overruled.

Findings of Fact

I. Factual History³

On June 22, 2011, Debtors Dustin and Brandy Westby filed a voluntary Chapter 7 petition.⁴ The Westbys' Schedule C claimed as exempt the “Earned Income Credit” with a current value of “Unknown.” ⁵ The Westbys received their federal and state tax refunds on or about March 5, 2012. ⁶ The Westbys' total federal refund received was $6702, and their total federal EIC was $5751.⁷ The Westbys received a total state refund of $1490; their total state EIC was $1035.⁸

II. Procedural History

The Trustee timely objected to the Westbys' attempt to exempt the 2011 EIC under Kansas Senate Bill No. 12 (“Senate Bill No. 12”),⁹ and the Westbys filed a response.¹⁰ The Trustee's objection to the EIC exemption contained a constitutionality challenge to the Senate Bill No. 12 exemption.¹¹ The Court certified that constitutional objection to the Kansas Attorney General, who has intervened in this case. Although the Westbys received their bankruptcy discharge on September 30, 2011, this case remains pending as a Chapter 7 case.

III. The Earned Income Credit

The federal EIC, found in the Internal Revenue Code (“IRC”) at 26 U.S.C. § 32, is characterized as a refundable tax credit.¹² An individual's tax credits are applied to the tax otherwise owed for a given year, and are considered an overpayment of tax under the IRC when they exceed the tax owed, thereby resulting in a tax refund.¹³ “An individual who is entitled to an earned-income credit that exceeds the amount of tax he owes thereby receives the difference as if he had overpaid his tax in that amount.” ¹⁴ The Supreme Court has noted that the federal EIC “was enacted to reduce the disincentive to work caused by the imposition of Social Security taxes on earned income (welfare payments are not similarly taxed), to stimulate the economy by funneling funds to persons likely to spend the money immediately, and to provide relief for low-income families hurt by rising food and energy prices.” ¹⁵ “Primarily, the EIC benefits low-income married couples and heads of households with qualifying dependent children.” ¹⁶ Kansas's EIC is computed as a percentage of the federal EIC.¹⁷

Conclusions of Law

I. An Introduction to Senate Bill No. 12 and Exemptions under the Bankruptcy Code

Under the Bankruptcy Code, when a debtor files a petition for bankruptcy relief, an estate is created.¹⁸ That bankruptcy estate consists of “all legal or equitable interests of the debtor in property as of the commencement of the case.” ¹⁹ The Bankruptcy Code does, however, permit the exemption of certain property from the estate.²⁰ The Bankruptcy Code includes a list of federal exemptions available to the debtor, ²¹ but permits a state to “opt-out” of the federal exemptions in favor of state-law exemptions, when that state specifically excludes the use of the federal exemptions.²² Kansas has opted out of the federal exemption scheme.²³ Because Kansas has opted out of using the federal exemptions, the Kansas debtor may exempt from the estate those “State or local law” exemptions that are “applicable as of the filing date.” ²⁴

The Trustee challenges the constitutionality of the newest exemption. Senate Bill No. 12, titled “AN ACT concerning civil procedure; relating to bankruptcy; exempt property; earned income tax credit,” states as follows:

Section 1. An individual debtor under the federal bankruptcy reform act of 1978 (11 U.S.C. § 101 et seq.), may exempt the debtor's right to receive tax credits allowed pursuant to section 32 of the federal internal revenue code of 1986, as amended, and K.S.A. 2010 Supp. 79–32,205, and amendments thereto. An exemption pursuant to this section shall not exceed the maximum credit allowed to the debtor under section 32 of the federal internal revenue code of 1986, as amended, for one tax year. Nothing in this section shall be construed to limit the right of offset, attachment or other process with respect to the earned income tax credit for the payment of child support or spousal maintenance.

Sec. 2. This act shall take effect and be in force from and after its publication in the Kansas register.²⁵

The statute was effective on April 14, 2011, with its publication in the Kansas Register.²⁶

The legislative history of Senate Bill No. 12 shows that the exemption was proposed and supported based on concerns regarding the ability of “low income Kansans ... to maintain and improve their lives.” ²⁷ The sponsor of the exemption further stated: “Under current law, the debtor can be forced to forfeit the [refund of the EIC]. Such forfeiture is counterproductive and further inhibits the debtor's ability to recover, making it more likely that the debtor will come to require state services.” ²⁸ The Kansas Attorney General, therefore, argues that the exemption is based on a “legitimate state interest—protecting the welfare of children in low income families and promoting reliance on work instead of the public dole.” ²⁹ Notwithstanding those laudable goals, there is no legislative history found by this Court (or cited by the parties) that specifies why the exemption was given only to debtors in bankruptcy but not to general debtors in Kansas outside of bankruptcy.

In a challenge to a claimed exemption, the objecting party—here the Trustee—has the “burden of proving that the exemptions are not properly claimed.” ³⁰ Furthermore, in cases challenging the constitutionality of a state statute, a Court must apply a presumption that the act of the state legislature is constitutional.³¹ In addition, under Kansas law, exemption statutes are to be liberally construed for the benefit of the debtor.³²

The Court has jurisdiction to decide contested matters such as the Trustee's objection to exemption.³³ This matter constitutes a core proceeding. ³⁴

II. The Trustee Has Standing to Raise an Objection to Exemption and the Matter is Ripe for Consideration

A. Standing

The Court must assure itself of the Trustee's standing to object to a debtor's claimed exemption.³⁵ Standing jurisprudenceencompasses both constitutional standing and prudential standing.³⁶ Constitutional standing requires the presence of a “case or controversy,” and requires that the individual has suffered “an ‘injury in fact’ that a favorable judgment will address.” ³⁷ Prudential standing requires that the litigant assert its own particular rights, and forbids a litigant from “ ‘rest[ing] his claim for relief on the legal rights or interest of third parties.’ ” ³⁸

In its analysis, the Court first notes that Bankruptcy Rule 4003(b)(1) provides that “a party in interest may file an objection to the list of property claimed as exempt.” Although the phrase “party in interest” is not a defined term in the Bankruptcy Code or Rules, it is generally accepted that a Trustee is a party in interest.³⁹

The Attorney General argues that the Trustee lacks standing because a trustee's role is to stand in the shoes of a debtor in bankruptcy, and the Trustee cannot assert the rights of a general debtor in Kansas, not a party to the bankruptcy, who may be injured by the unavailable exemption of EIC. ⁴⁰ To the contrary, the Trustee is not limited to considerations only affecting the debtor in bankruptcy. As “the representative of the estate,” ⁴¹ the Trustee is under a duty to “collect and reduce to money the property of the estate.” ⁴² Despite this statutory mandate, the Attorney General argues that an injury to a creditor is “incidental” to the bankruptcy. Again, however, the Trustee's duty to collect and account for the property of the estate, so that estate property can be distributed to creditors,⁴³ is not an incidental feature of the Code.

Bankruptcy serves two purposes. While its primary purpose is to give the debtor in bankruptcy a fresh start, it is also designed to ensure the fair and equitable treatment of the creditors of a debtor in bankruptcy. ⁴⁴ Whether an exemption is constitutional or properly claimed most certainly affects the property available to the estate that is available for creditors. The Trustee is a party in interest with standing to object to the exemption claimed herein.

B. Ripeness

The Court must also...